UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the transition period from                       to                      

Commission File Number 1-10346

EMRISE CORPORATION

(Exact name of registrant as specified in its charter)

9485 Haven Avenue, Suite 100

Rancho Cucamonga, California 91730

(Address of principal executive offices) (Zip code)

(909) 987-9220

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

                   Large Accelerated Filer o               Accelerated Filer o             Non-Accelerated Filed x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

The number of shares outstanding of the Registrant’s common stock, $0.0033 par value, as of November 9, 2007 was 38,254,250.

EMRISE CORPORATION

TABLE OF CONTENTS

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

PART I — FINANCIAL INFORMATION

ITEM 1.                             FINANCIAL STATEMENTS

EMRISE CORPORATION

Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements

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EMRISE CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)
(in thousands, except per share amounts)

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements

2

EMRISE CORPORATION

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)
(in thousands)

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements

3

EMRISE CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)
(in thousands)

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements

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NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

EMRISE Corporation (the “Company”) operates through two operating segments: electronic devices and communications equipment. The Company’s subsidiaries within its electronic devices segment design, develop, manufacture and market electronic devices for defense, aerospace and industrial markets.  The Company’s subsidiaries within its communications equipment segment design, develop, manufacture and market network access equipment and network timing and synchronization products.  The Company conducts its operations out of various facilities in the United States (“U.S.”), France, the United Kingdom (“U.K.”) and Japan.  The following reflects the Company’s direct subsidiaries, as indicated, and indirect subsidiaries and the locations of operation:

Electronic Devices Segment

EMRISE Electronics Corporation (“EEC”), a subsidiary of the Company — U.S.

EMRISE Electronics Limited (“EEL”) — U.K.

Pascall Electronics Limited (“Pascall”) — U.K.

XCEL Power Systems, Ltd. (“XPS”) — U.K.

RO Associates Incorporated (“RO”) — U.S.

EMRISE Japan Ltd. (“EJL”) — Japan

Communications Equipment Segment

        CXR Larus Corporation (“CXR Larus”), a subsidiary of the Company — U.S.

        CXR Anderson Jacobson (“CXR-AJ”), a subsidiary of the Company — France

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“Commission”) and therefore do not include all information and footnotes necessary for a complete presentation of the financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the U.S. (“GAAP”).  The year end balance sheet was derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.  The unaudited condensed consolidated financial statements do, however, reflect all adjustments, consisting of only normal recurring adjustments, which are, in the opinion of management, necessary to state fairly the financial position as of September 30, 2007 and the results of operations and cash flows for the related interim periods ended September 30, 2007 and 2006. However, these results are not necessarily indicative of results for any other interim period or for the year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its amended annual report on Form 10-K for the year ended December 31, 2006 as filed with the Commission.

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Comprehensive Loss

Comprehensive loss includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders.  Other comprehensive income refers to revenues, expenses, gains and losses that, under GAAP, are included in comprehensive income, but excluded from net loss as these amounts are recorded directly as an adjustment to stockholders’ equity.  The Company’s other comprehensive income consists of foreign currency translation adjustments.  The following table reflects the components of comprehensive loss (in thousands):

Loss Per Share

Basic loss per share is computed by dividing net loss by the weighted average common shares outstanding during a period.  Diluted loss per share is based on the treasury stock method and includes the dilutive effect of stock options and warrants outstanding during the period.  Common share equivalents have been excluded where their inclusion would be anti-dilutive.  As a result of the loss incurred by the Company for all periods presented, the potentially dilutive common shares have been excluded because their inclusion would have been anti-dilutive.  The following table illustrates the computation of basic and diluted loss per share (in thousands, except per share amounts):

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The following table shows the common stock equivalents that were outstanding as of September 30, 2007 and 2006, but were not included in the computation of diluted earnings per share as a result of the loss incurred by the Company or because the options’ or warrants’ exercise price was greater than the average market price of the common shares and, therefore, the effect would have been anti-dilutive:

Recent Accounting Pronouncements

On January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Financial Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for the uncertainty in recognizing income taxes in an organization in accordance with FASB Statement No. 109 by providing detailed guidance for financial statement recognition, measurement and disclosure involving uncertain tax positions.  FIN 48 requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective date to be recognized both upon the adoption of FIN 48 and in subsequent periods.  The implementation of FIN 48 did not have a material effect on the Company’s financial statements.  See Note 6 — Income Taxes.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets and liabilities and certain other items including insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense up front cost and fees associated with the item for which the fair value option is elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is evaluating the effect that adoption of SFAS No. 159 would have on its financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This new statement provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy, with the highest priority being quoted prices in active markets. The required effective date of SFAS No. 157 is the first quarter of 2008. The Company is evaluating the effect this statement may have on its consolidated financial statements.

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NOTE 2 — STOCK-BASED COMPENSATION

The Company has four stock option plans:

•                  Employee Stock and Stock Option Plan, effective July 1, 1994;

•                  1993 Stock Option Plan;

•                  1997 Stock Incentive Plan; and

•                  Amended and Restated 2000 Stock Option Plan.

As a result of the Company’s adoption of SFAS No. 123 (revised 2004), “Share-Based Payment,” as of January 1, 2006, total stock-based compensation expense included in wages, salaries and related costs was $15,000 and $36,000 for the three months ended September 30, 2007 and 2006, respectively, and $60,000 and $110,000 for the nine months ended September 30, 2007 and 2006, respectively. These compensation expenses were charged to selling, general and administrative expenses. As of September 30, 2007, the Company had $43,000 of total unrecognized compensation expense related to stock option grants, which will be recognized over the remaining weighted average period of two years.

NOTE 3 — INVENTORIES

                Inventories are stated at the lower of cost (first-in, first-out method) or market (net realizable value) and consisted of the following (in thousands):

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NOTE 4 — OPERATING SEGMENTS

The Company has two reportable operating segments: electronic devices and communications equipment. The electronic devices segment manufactures and markets digital and rotary switches, electronic power supplies, radio frequency (“RF”) and microwave devices and subsystem assemblies. The electronic devices segment consists of EEC and its subsidiaries, which offer the same or similar products to similar customers.  The communications equipment segment designs, manufactures and distributes network access products and timing and synchronization products.  The communications equipment segment consists of operating entities CXR Larus and CXR-AJ, which offer the same or similar products to similar customers.  Both segments operate in the U.S., European and Asian markets, but have distinctly different customers, design and manufacturing processes and marketing strategies.  Each segment has discrete financial information and a separate management structure.

The Company evaluates performance based upon profit or loss from operations before income taxes exclusive of nonrecurring gains and losses. The Company accounts for intersegment sales at pre-determined prices negotiated between the individual segments.

There were no differences in the basis of segmentation or in the basis of measurement of segment operating income or loss from the amounts disclosed in the Company’s audited consolidated financial statements included in its annual report on Form 10-K for the year ended December 31, 2006.  Included in the Company’s reconciliation of segment financial data to the consolidated amounts is unallocated corporate expenses.  Selected financial data for each of the Company’s operating segments reconciled to the consolidated totals is shown below (in thousands):

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NOTE 5 — GOODWILL

                The following table reflects changes in our goodwill balances, by segment, for the nine months ended September 30, 2007 (in thousands):

NOTE 6 — INCOME TAXES

The effective tax rate for the three and nine month periods ended September 30, 2007 was different than the 34% U.S. statutory rate primarily because of foreign taxes on foreign source income that cannot be offset by domestic tax loss carryforwards.

On January 1, 2007, the Company adopted FIN 48. The implementation of FIN 48 did not result in a material adjustment to the Company’s liability for unrecognized income tax benefits. At the time of adoption and as of the end of the second quarter of 2007, the Company had recorded no net unrecognized tax benefits. The Company does not believe that it will record unrecognized tax benefits for 2007.

The Company recognizes interest and penalties related to uncertain tax positions in interest expense and selling, general and administrative expense, respectively, in the condensed consolidated statements of operations and comprehensive income. No interest or penalties were recognized during the first half of 2007. As of September 30, 2007, the Company had nothing accrued for interest and penalties in this regard.

The Company files income tax returns in the U.S. federal jurisdiction, the U.K., France and Japan, and in the state jurisdictions of California, Texas and New Jersey. The Company is no longer subject to U.S. federal and state tax examinations for years before 2003 and 2002, respectively, and is no longer subject to tax examinations for the U.K. and Japan for years prior to 2005, and for France for years prior to 2003.

NOTE 7 — LINES OF CREDIT

Outstanding borrowings under the Company’s revolving lines of credit described below were as follows:

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EMRISE Corporation, EEC, CXR Larus, RO and Wells Fargo Bank, acting through its Wells Fargo Business Credit operating division (“WFBC”), are parties to a Credit and Security Agreement (“WFBC credit facility”).  The WFBC credit facility provides for a $5.0 million revolving line of credit that expires on December 1, 2009 and is secured by accounts receivable, other rights to payment and general intangibles, inventories and equipment.  The Company is subject to certain financial covenants associated with the WFBC credit facility, including minimum net worth, minimum net income (loss), and minimum debt service coverage ratio.  In August 2007, the Company amended the WFBC credit facility to reset these covenants.  On October 5, 2007, the Company entered into a Forbearance Agreement and Second Amendment with WFBC.  Under the terms of this second amendment, WFBC agreed to forbear its rights with regard to the July 31, 2007 covenant violations through December 31, 2007 provided that the Company meets certain temporary financial covenants (collectively, the “Financial Tests”), during the forbearance period including minimum book net worth and minimum net income.  As of September 30, 2007, the Company was in compliance with the Financial Tests as required by the Forbearance Agreement and Second Amendment.  WFBC is currently in the process of resetting the covenants for 2008.

The Company’s indirect subsidiaries, Pascall and XPS, are parties to a credit facility with Lloyds TSB Commercial Finance Limited (“Lloyds”) that provides a revolving loan secured by receivables, with a maximum availability of 2.1 million British pounds sterling (approximately $4.2 million based on the exchange rate in effect on September 30, 2007).  The Company is subject to certain financial covenants associated with the Lloyd’s credit facility.  As of September 30, 2007, the Company was in compliance with all such covenants.

CXR-AJ is party to a credit facility with IFN Finance, a subsidiary of ABN AMRO N.V.  This credit facility is for a maximum of $1.3 million based on the exchange rate in effect at September 30, 2007 for the conversion of euros into U.S. dollars.  The IFN credit facility is secured by accounts receivable.  The IFN credit facility has no financial performance covenants.

                During the quarter ended September 30, 2007, the Company entered into a note with one of its vendors, the amount of which may not exceed $300,000, relating to trade payables for raw materials recieved during 2007.  Pursuant to the terms of the note, the Company pledged 500,000 shares of restricted common stock as collateral to support the note.  As of September 30, 2007 the balance on the note was $165,000.

NOTE 8 — SUBSEQUENT EVENTS

                On November 7, 2007, the Company secured a commitment letter from GVEC Resource IV, Inc., an affiliate of Private Equity Management Group (“PEM Group”), to provide a three year global debt facility (the “Financing Transaction”).  The facility totals $23 million comprised of a $7 million formula-based revolving credit facility, a $6 million term loan, which funds entirely at the time of closing, and a $10 million line of credit to be used exclusively for purposes of acquisitions.  Proceeds from the credit facility and the term loan will be used to repay existing institutional debt and to fund working capital.  The interest rate on the revolving credit facility is variable at the prime rate as published in the “Money Rates” column of the Wall Street Journal plus 1.25% subject to a minimum of 9.5%.  The interest rate on the term loan and acquisition line is variable at the prime rate plus 4.25% subject to a minimum of 12.5%.  The term loan and, if used, the acquisition line require interest only payments in the first year and scheduled principal and interest payments in years two and three with the remaining principal balance due upon maturity of the term loan.  The Financing Transaction is expected to close on or before December 7, 2007.  In connection with the Financing Transaction,  the Company will issue to PEM Group a warrant to purchase 2,909,091 shares of the Company’s common stock at an exercise price of $1.10 per share.  The warrants will expire in seven years.  The closing of the Financing Transaction is subject to acceptable final documentation and customary closing conditions.

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ITEM 2.                             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Cautionary Statement

You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with SEC, including our Annual Report on Form 10-K for the year ended December 31, 2006 and subsequent reports on Forms 10-Q and 8-K, which discuss our business in greater detail.

The section entitled “Risk Factors” set forth below, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.

All statements included or incorporated by reference in this Report, other than statements or characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected net revenue, costs and expenses and gross margin; our accounting estimates, assumptions and judgments; the impact of the January 2007 restatement of our financial statements for prior periods; estimates related to the amount and/or timing of the expensing of unearned stock-based compensation expense; our success in pending litigation; the demand for our products; the effect that seasonality and volume fluctuations in the demand for our customers’ consumer-oriented products will have on our quarterly operating results; our dependence on a few key customers for a substantial portion of our revenue; our ability to scale operations in response to changes in demand for existing products and services or the demand for new products requested by our customers; the competitive nature of and anticipated growth in our markets; our ability to migrate to smaller process geometries; manufacturing, assembly and test capacity; our ability to consummate acquisitions and integrate their operations successfully; our potential needs for additional capital and inventory and accounts receivable levels. These forward-looking statements are based on our current expectations, estimates and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section “Risk Factors” contained in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.

General

We are a Delaware corporation that was formed July 14, 1989 and operates through subsidiaries in two operating segments: electronic devices and communications equipment. Our subsidiaries within our electronic devices segment design, develop, manufacture and market electronic devices for defense, aerospace and industrial markets, including digital and rotary switches, electronic power supplies and radio frequency (“RF”) device systems and subsystem assemblies.  Our subsidiaries within our communications equipment segment design, develop, manufacture and market network access equipment, including network timing and synchronization products for communications service providers.  We are a multinational company operating out of facilities located in the United States (“U.S.”), United Kingdom (“U.K.”), France and Japan.  The following reflects our direct subsidiaries, as indicated and indirect subsidiaries and their locations of operation:

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Electronic Devices Segment

        EMRISE Electronics Corporation (“EEC”), a subsidiary of EMRISE — U.S.

EMRISE Electronics Limited (“EEL”) — U.K.

Pascall Electronics Limited (“Pascall”) — U.K.

XCEL Power Systems, Ltd. (“XPS”) — U.K.

RO Associates Incorporated (“RO”) — U.S.

EMRISE Japan Ltd. (“EJL”) — Japan

Communications Equipment Segment

        CXR Larus Corporation (“CXR Larus”), a subsidiary of EMRISE — U.S.

        CXR Anderson Jacobson (“CXR-AJ”), a subsidiary of EMRISE — France

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of those financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of net sales and expenses for each period. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

We derive revenues from sales of electronic devices and communications equipment products and services.  Our sales are based upon written agreements or purchase orders that identify the type and quantity of the item and/or services being purchased and the purchase price.  We recognize revenues when shipment of products has occurred or services have been rendered, no significant obligations remain on our part, and collectability is reasonably assured based on our credit and collections practices and policies.

We recognize revenues from domestic sales of our electronic devices and communications equipment at the point of shipment of those products.  Product returns are infrequent and require prior authorization because our sales are final and we quality test our products prior to shipment to ensure they meet the specifications of the binding purchase orders under which they are shipped. Normally, when a customer requests and receives authorization to return a product, the request is accompanied by a purchase order for a replacement product.

Revenue recognition for products and services provided by our U.K. subsidiaries depends upon the type of contract involved.  Engineering/design services contracts generally entail design and production of a prototype over a term of up to several years, with revenue deferred until each milestone defined in the contract is reached.  Production contracts provide for a specific quantity of products to be produced over a specific period of time.  Customers issue binding purchase orders for the products to be produced.  We recognize revenues on these orders as the products are shipped.  Returns are infrequent and permitted only with prior authorization because these products are custom made to order based on binding purchase orders and are quality tested prior to shipment.  Generally, these products carry a one-year limited parts and labor warranty.

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We recognize revenues for products sold by our French subsidiary at the point of shipment.  Customer discounts are included in the product price list provided to the customer.  Returns are infrequent and permitted only with prior authorization because these products are shipped based on binding purchase orders and are quality tested prior to shipment.  Generally, these products carry a two-year limited parts and labor warranty.

Revenues from services such as repairs and modifications are recognized when the service is completed and invoiced.  For repairs that involve shipment of a repaired product, we recognize repair revenues when the product is shipped back to the customer. Service revenues contribute less than 5% of total revenue and, therefore, are considered to be immaterial to overall financial results.

Product Warranty Liabilities

Generally, our electronic devices, network access and transmission products and communication timing and synchronization products carry a one-year, limited parts and labor warranty and our communications test instruments and European network access and transmission products carry a two-year limited parts and labor warranty.  Products returned under warranty typically are tested and repaired or replaced at our option.  Historically, we have not experienced significant warranty costs or returns.

We record a liability for estimated costs that we expect to incur under our basic limited warranties when product revenue is recognized.  Factors affecting our warranty liability include the number of units sold, historical and anticipated rates of claim and costs per claim.  We periodically assess the adequacy of our warranty liability accrual based on changes in these factors.

Inventory Valuation

Our finished goods electronic devices inventories generally are built to order.  Our communications equipment inventories generally are built to forecast, which requires us to produce a larger amount of finished goods in our communications equipment business so that our customers can promptly be served.  Our products consist of numerous electronic and other parts, which necessitates that we exercise detailed inventory management.  We value our inventory at the lower of the actual cost to purchase or manufacture the inventory (first-in, first-out) or the current estimated market value of the inventory (net realizable value). We perform cycle counts of inventories using the ABC inventory methodology or conduct physical inventories at least once a year.  We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. Additionally, to determine inventory write-down provisions, we review product line inventory levels and individual items as necessary and periodically review assumptions about forecasted demand and market conditions.  Any parts or finished goods that we determine are obsolete, either in connection with the physical count or at other times of observation, are reserved for and subsequently discarded and written-off.  As of September 30, 2007, our total inventory reserves amounted to $6.3 million of which $4.5 million, or 25.0% of total inventory, related to our electronic devices segment and $1.9 million, or 10.5% of total inventory, related to our communications equipment segment.

The electronics devices and communications equipment industries are characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Also, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.

Foreign Currency Translation

We have foreign subsidiaries that together accounted for approximately 71.4% and 62.7% of our net revenues, 59.4% and 52.3% of our assets and 57.4% and 49.6% of our total liabilities as of and for the nine months ended September 30, 2007 and 2006, respectively.  In preparing our consolidated financial statements, we are required to translate the financial statements of our foreign subsidiaries from the currencies in which they keep their accounting records into U.S. dollars. This process results in exchange gains and losses which, under relevant accounting guidance, are included either within our statement of operations under the caption “other income (expense)” or as a separate part of our net equity under the caption “accumulated other comprehensive income (loss).”

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Under relevant accounting guidance, the treatment of these translation gains or losses depends upon our management’s determination of the functional currency of each subsidiary. This determination involves consideration of relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency. However, management must also consider any dependency of the subsidiary upon the parent and the nature of the subsidiary’s operations.

If management deems any subsidiary’s functional currency to be its local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements is included as a separate component of stockholders’ equity in accumulated other comprehensive income (loss).  However, if management deems the functional currency to be U.S. dollars, then any gain or loss associated with the translation of these financial statements would be included in other income (expense) within our statement of operations.

If we dispose of any of our subsidiaries, any cumulative translation gains or losses would be realized into our statement of operations. If we determine that there has been a change in the functional currency of a subsidiary to U.S. dollars, then any translation gains or losses arising after the date of the change would be included within our statement of operations.

Based on our assessment of the factors discussed above, we consider the functional currency of each of our international subsidiaries to be each subsidiary’s local currency. Accordingly, we had cumulative translation gains of $1.0 million and $0.7 million that were included as part of accumulated other comprehensive income within our balance sheets at September 30, 2007 and December 31, 2006, respectively. During the nine months ended September 30, 2007 and 2006, we included translation gains of $0.3 million and $1.0 million, respectively, under accumulated other comprehensive income.

If we had determined that the functional currency of our subsidiaries was U.S. dollars, these gains would have decreased our net loss for the nine months ended September 30, 2007 and 2006. The magnitude of these gains or losses depends upon movements in the exchange rates of the foreign currencies in which we transact business as compared to the value of the U.S. dollar. These currencies include the euro, the British pound sterling and, to a lesser extent, the Japanese yen. Any future translation gains or losses could be significantly higher or lower than those we recorded for these periods.

A 2.5 million British pound sterling loan payable from EEL to EMRISE was outstanding as of September 30, 2007 ($5.5 million based on the exchange rate at September 30, 2007).  Exchange rate losses and gains on the long-term portion of this loan are recorded in cumulative translation gains or losses in the equity section of the balance sheet.

Intangibles, Including Goodwill

We periodically evaluate our intangibles, including goodwill, for potential impairment. Our judgments regarding the existence of impairment are based on legal factors, market conditions and operational performance of our acquired businesses.

In assessing potential impairment of goodwill, we consider these factors as well as forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have to record additional impairment charges not previously recognized. In assessing the recoverability of our goodwill and other intangibles, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of those respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets that were not previously recorded.  If that were the case, we would have to record an expense in order to reduce the carrying value of our goodwill.  Under Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, we are required to analyze our goodwill for impairment issues at least annually or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  At September 30, 2007, our reported goodwill totaled $13.1 million.  During the nine months ended September 30, 2007, we did not record any impairment losses related to goodwill and other intangible assets.

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Overview

Overall sales increased 5.2% and 9.1% in the three months and nine months ended September 30, 2007, respectively, from the same periods in 2006.  Sales were positively affected at our foreign subsidiaries in both of our operating segments, electronics devices and communications equipment, as a result of new contracts for power supplies, new in-flight entertainment and communication products, or IFE&C, and network access products.  The sales increases for our foreign subsidiaries were partially offset by sales declines for our domestic subsidiaries.  While we continue to experience year-over-year decreases in our domestic sales, we have already seen improvements in domestic sales of our rotary switches and new TiemPoTM edge network timing product, or TiemPoTM, due, inpart, to new orders for TiemPoTM by a national communications carrier.  We expect continued growth in our foreign markets and we believe that our new TiemPo™ product and our patented Very Low Profile, or VLP, rotary switches will bring improved sales to our domestic operations as well.

Overall gross margins decreased 7.1 and 5.7 percentage points for the third quarter and year-to-date periods in 2007, respectively, from the same periods in 2006.  The declines in gross margins were primarily due to the remaining effects of transitioning the manufacturing of our RO products to a contract manufacturer, which commenced in the second quarter of 2007 and resulted in lower sales and higher initial production costs; the temporary higher costs associated with engineering and prototyping of our new IFE&C products at our U.K. subsidiaries; and changes in product mix as we are experiencing the impact of shifting from higher margin legacy products to lower-margin, long-term growth products.  We have made a conscious effort to develop and pursue product lines in areas where we expect substantial growth potential.  In some cases, these opportunities, such as existing products sold in the IFE&C market, have lower margins as compared to our traditional higher margin military market resulting in lower overall average margins.  Similarly, our rotary switch product line is a lower margin product than our traditional legacy digital switch products, but with a substantial future growth potential.  In all cases, however, we expect that the overall higher anticipated sales volumes in these high growth areas will result in improved gross profit and overall improved profitability.  In contrast, our new TiemPoTM products have both high growth potential and higher margin potential.  Therefore, we are particularly excited about the growth of this product.  We expect our margins throughout the remainder of 2007 to remain relatively consistent with the margins we experienced during the third quarter of 2007.

We are encouraged by our continued sales growth reflecting the market interest in our new products.  Our strategy is to continue to generate market acceptance of these products, manage general and administrative costs and seek acquisition opportunities that will compliment our existing product lines and customer base.

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The following is a further, more detailed discussion of our results of operations by segment.

Results of Operations

Comparison of the Three Months Ended September 30, 2007 to the Three Months Ended September 30, 2006

Net Sales

Electronic Devices Segment

The increase in sales of electronic devices in the third quarter of 2007 as compared to the third quarter of 2006 is primarily due to a $1.0 million increase in sales at our foreign subsidiaries.  This was primarily the result of military power supply sales in our U.K. subsidiary due to new contracts and also due to increased revenues from both existing and new IFE&C products.  This increase was partially offset by $0.7 million in sales declines at our domestic operations primarily due to delays in U.S. government stocking orders by the Defense Supply Center Columbus (“DSCC”) for our digital switches and the remaining impact of the transition of the manufacturing operations of our RO products to a contract manufacturer, which occurred during the second quarter of 2007.  Approximately $0.4 million of sales were delayed as a result of low production rates at the new contract manufacturer associated with the set up and execution of the assembly process.  We expect our electronic devices segment sales to improve in the fourth quarter of 2007 as compared to the third quarter of 2007, primarily due to the following:

•                  higher IFE&C shipments anticipated in the fourth quarter of 2007;

•                  improved shipments at RO as a result of ongoing efforts to improve manufacturing efficiencies with contract manufacturer and as they continue to satisfy existing backlog of $0.9 million; and

•                  the possible release in the fourth quarter of 2007 of high gross margin switch shipments at our Digitran division as a result of ongoing efforts to work with DSCC to release orders that have been requested, but not released throughout 2007, which total $0.9 million as of September 30, 2007.

Communications Equipment Segment

The increase in sales of communications equipment in the third quarter of 2007 as compared to the third quarter of 2006 is primarily due to a $0.7 million increase in sales of network access equipment at our French subsidiary as a result of new contracts and larger international orders and an increase of $0.2 million in domestic network access equipment sales, primarily the result of FAA upgrades to North American airports.  The increase was partially offset by declines in our domestic operations as a result of decreases in sales of our central office timing products.  Sales of our central office timing products have been slower than in 2006 as a result of a market shift from central office to edge network products.  We expect to experience strong sales from our French subsidiary for the remainder of the year as evidenced by an increase in backlog to $1.1 million at September 30, 2007 as compared to $0.8 million at September 30, 2006.  We also expect improved sales in both our domestic and foreign operations increased shipments of our new TiemPoTM product in both the U.S. and Europe due, in part, to new orders for TiemPoTM by a national communications carrier customer, which will begin shipping in the fourth quarter of 2007.

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Gross Profit

Electronic Devices Segment

The decline in gross margin for our electronic devices segment from 37.7% in the third quarter of 2006 to 28.6% in the third quarter of 2007 is primarily the result of the continued effect of the transition of RO manufacturing to a contract manufacturer, which commenced in the second quarter of 2007 and resulted in higher initial production costs; temporary engineering and prototyping costs associated with new IFE&C products; changes in product mix from higher margin products with limited life spans to lower margin, high growth rotary switch products; and the ongoing delayed release of DSCC stocking orders for high margin digital switch products, which totaled $0.9 million as of September 30, 2007.  Additionally, we are making a conscious effort to penetrate the lower margin commercial in-flight entertainment market as we see substantial growth potential as compared to our traditional higher margin military market resulting in lower average margins for those products.  We expect to see these margins improve in the fourth quarter due to:

•                  anticipated IFE&C product shipments that will generate higher margins than currently being generated as engineering and prototype activities are replaced by higher margin product shipments;

•                  improved manufacturing efficiencies with the RO contract manufacturer and increased shipments of products to satisfy existing backlog of $0.9 million; and

•                  the expected release in the fourth quarter of 2007 of high gross margin switch shipments at our Digitran division as a result of ongoing efforts to work with DSCC to release orders that have been requested, but not released as of September 30, 2007.

Communications Equipment Segment

The decline in gross margin for our communications equipment segment from 40.1% in the third quarter of 2006 to 37.4% in the third quarter of 2007 is primarily the result of a decrease in margins at our domestic subsidiaries due to lower sales of our central office timing products as the market shifts to edge network products, offset in part by increased sales of higher margin military network access products at our French subsidiary.  Margins have increased slightly over second quarter 2007 primarily as a result of the launch of our new TiemPo^TM product which carries a higher margin and which we expect will help our margins in the fourth quarter of 2007 remain relatively consistent with the third quarter of 2007.

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Operating Expenses

Selling, general and administrative expenses

The decrease in selling, general and administrative expenses is primarily the result of $0.7 million of costs for the restatement and reaudit of our 2004 and 2005 financial statements, which were incurred in the third quarter of 2006 and were absent in the third quarter of 2007.  Additionally, the volatility of the U.S. dollar to the British pound sterling and euro contributed to the favorable variance.

Engineering and product development

The decrease in engineering and product development costs is primarily due to reduced expenses for the development of the new TiemPoTM product line for which most of the costs were incurred in 2006.  Development costs incurred for this new product were $0.1 million in the third quarter of 2007 compared to $0.2 million in the third quarter of 2006.

Interest expense

Interest expense was $0.2 million for the three months ended September 30, 2007 compared to $0.1 million for the three months ended September 30, 2006 due to increased loan balances for our U.S., U.K. and French operations and increased interest rates.

Other income (expense)

We generated other income of $0.3 million for the three months ended September 30, 2007 compared to other expense of approximately $0.2 million for the same period of 2006.  Other income for the third quarter of 2007 included a one-time accrual reversal related to the satisfactory resolution of a legal dispute at our French subsidiary, CXR AJ.  Other expense for the third quarter of 2006 consisted primarily of short-term exchange rate gains and losses associated with the volatility of the U.S. dollar to the British pound sterling and euro on the current portion of certain assets and liabilities.

Income tax expense

Income tax expense amounted to $0.2 million for the three months ended September 30, 2007 compared to $0.1 million for the same period of 2006.  Income tax expense is the result of foreign income tax on foreign earned profits.

Net Loss

We generated a net loss of $0.5 million and $0.7 million for the three months ended September 30, 2007 and 2006, respectively.  Our third quarter 2007 net loss position improved over the net loss for the prior year third quarter.  Factors that contributed to the current quarter net loss were the disruption in sales at RO as a result of the conversion of the manufacturing of RO products to contract manufacturing, delayed DSCC orders and the lower margins generated from our change in product mix to commercial from military markets offset by a one-time accrual reversal related to the satisfactory resolution of a legal dispute at our French subsidiary, CXRAJ.

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Comparison of the Nine months Ended September 30, 2007 to the Nine months Ended September 30, 2006

Net Sales